Class of 2021 NextGens

Rob Kenney’s interest in finance was sparked by a high school class where he worked on a group project that required the team to select, research, and monitor a handful of stocks for a year. He enjoyed the qualitative and quantitative components combined with the competition amongst teams. Along the way, he collected a bachelor’s degree from Villanova University and an MBA from the University of South Carolina. He holds the CFA and CAIA designations. At his first two jobs, SEI and Citigroup, he had back office roles in operations. At Tremblant Capital, a long-short equity hedge fund, he had the opportunity to sit on the trading desk, but worked for the TMT group as a research assistant. Attalus Capital provided him the chance to be an allocator at a fund-of-hedge funds focused on long-short strategies, which was great experience for his current role at Furman University.

He moved to Furman in 2012, where his knowledge of and network within long-only equity and hedge fund strategies has had a meaningful contribution. Hedge funds are approximately 18% of the portfolio. Kenney has also enjoyed the opportunity to conduct research across other asset classes. In addition, understanding the university’s mission and being able to have an impact on students has truly been rewarding. Kenney and his colleague Kris Kapoor had the opportunity to co-teach investment management for two semesters. They also typically have an intern in the fall where they have the chance to act as mentors. On their small team, culture is very important and complementary skillsets are essential. Kenney says that Kapoor is an exceptional leader with an incredible work ethic that has inspired him to practice kaizen or “continuous improvement” in every aspect of his job.

CIO: How would you deal with rising inflation and interest rates?

Kenney: CPI has averaged roughly 2% for the past 20 years. But April 2021 saw a YoY increase of 4.2%, which was greater than the expected 3.6% increase and the largest YoY increase since September 2008. However, it’s important to remember that the base effects may have overstated inflation given that prices plummeted in April 2020. The question is whether this inflation increase is temporary (as the Fed and a lot of economists believe) or will it prove to be more persistent and result in a regime change. The five-year, five-year forward inflation rate is 2.3%, which is a level we last saw in Q4 2018. PCE is also running ahead of the Fed’s 2% objective and PPI continues to rise.

Similarly, five- and 10-year breakeven rates are 2.5% and 2.4%, respectively. No question, inflation expectations have increased, but will prices rise more than what’s already discounted by the market? Higher inflation seems to be the consensus and the risk most cited by market participants. Currently, it seems to be more of a short-term (3-6 month) risk. The fear is that the Fed falls behind the curve and we have runaway inflation similar to the 1970s that causes the Fed to raise rates earlier than has been communicated to the market.

Inflation could continue to move higher with wage growth, higher energy prices, travel/leisure, shelter and supply constraints, especially for building materials. See lumber (actually off around 20% since the early May peak, but look at the one-year chart), not to mention used car prices which saw a 10% surge in April. We aren’t making a tactical call either way given our long-term focus at Furman, but have continued to rebalance opportunistically over the years, adding to commodity exposure. Public equities, the largest allocation in our portfolio may hold up relatively well if revenues and earnings have time to adjust and grow in-line with inflation. High quality companies with pricing power should mitigate at least some of the inflation pressure. However, certain sectors like technology as they’ve seen since November have reacted negatively to higher rates given cash flows that are further out in the future. The Fed may also cause rates to backup if they decide to taper, which could be discussed at the next FOMC meeting.

In the investment office, a primary objective of ours is to preserve the real purchasing power of the endowment. Our Real Asset bucket, to which we have a 12% target is designed to serve as an inflation hedge. On the public side, we have a diversified (energy, metals and agriculture) long-only, futures-based commodity strategy benchmarked to the BCOM. It currently has about 11% of the fund in gold. We also hold a small position in REITs, but no longer hold TIPs. Private real assets are about 6% of the portfolio. We have an allocation to private real estate, which is a mix of value-add and opportunistic. Core real estate strategies also have the ability to preserve capital during inflationary periods. They tend to use less leverage and hold up better during downturns.

However, cap rates are not necessarily attractive. Our private energy strategies are all upstream with the exception of one manager who also provides exposure to power and renewables. WTI is up 43% YTD. The IEA recently reported that the oversupply created by the pandemic has almost cleared and oil inventories are generally back to the five-year average. Energy is a compelling inflation hedge given the underperformance of the sector for the last 10 years and oil has a close relationship with inflation, particularly PPI.

Infrastructure is an area that I would explore given Biden’s proposed plan and the need to improve roads, rails, telecom, water infrastructure, etc. The global movement to reduce carbon emissions to mitigate climate change is another tailwind for infrastructure. Infrastructure also offers a yield premium over public fixed income and RE. It makes sense to be short the dollar given the budget deficit and to at least research cryptocurrencies (specifically BTC) if the position doesn’t already exist in a diversified portfolio.

 Regarding higher rates, I would have an allocation to private debt, specifically to direct lending where middle-market loans are senior in the cap structure, are floating rate, have contractual cash flows and are a source of portfolio diversification. There’s also an illiquidity premium to capture. I think being short Treasuries which could be expressed through an ETF like SHV could be a good hedge in a portfolio with an equity bias. Lastly, given the steeper yield curve, I think it makes sense to have an allocation to a financials specialist or have a healthy allocation to the sector by maintaining exposure to value/cyclicality, which would also include energy and materials since I think the reflation/cyclical rebound trade still has legs. Financials are up 30% YTD, but the valuation is still compelling relative to the rest of the S&P sectors. A weaker dollar and desire to have an allocation to value would justify a meaningful allocation to ex-US equities. There’s also an attractive relative value case to be made for non-US equities given the significant outperformance of the US since the GFC.

CIO: What are your favorite alts, and why?

Kenney: I like hedge funds because that’s where I’ve had the most experience in my career. I worked at a long/short equity hedge fund in NYC for 3 years in what was my first front office role. I was able to observe the operations of each group, i.e. analysts, trading, middle office, IR, HR, legal, and IT which prepared me for my next position. I also began studying for the CFA during this three-year stretch. After that experience, I spent a little less than two years at a fund-of-hedge funds in Philadelphia.

I mainly focused on long/short equity, but was also able to work with colleagues on the other strategies that the firm covered. The firm had a talented group of analysts and I still remain in touch with many of them today. When I joined Furman, we had some overlap within hedge funds between my prior firm and the university. Since the GFC, hedge funds have been a source of controversy.

Some of my peers may state that the asset class (whether hedge funds are an asset class is up for debate) is what troubles them most due to the fees, transparency and underperformance. Several allocators have significantly reduced or completely withdrew from hedge funds. I agree that there’s a lot of competition, which has led to crowding or overlap across portfolios in general.

Unconventional monetary policy has certainly had an impact resulting in lower volatility, persistently low interest rates and challenges to shorting (not to mention the social media crowd). Passive and quant investing also grew immensely over this period. FAANGM dominated S&P 500 performance while the number of listed public companies shrank, reducing the opportunity set (many hedge funds now take positions in late-stage privates). Factor risks can’t be ignored given the violent rotations that seem to occur more and more frequently. On the other hand, Preqin recently reported that hedge fund AUM exceeded $4 trillion at the end of Q1 2021 and hedge funds had their best Q1 since 2006. There could be a shift taking place where flows are going back to strategies that intend to provide downside protection given stretched equity valuations and tight credit spreads – or a multi-asset bubble if you follow Jeremy Grantham.

At Furman, we’ve moved down the AUM scale and have invested in sector or regional specialists in search of more inefficiencies and less overlap. TMT and health care are the areas that seem to work best for long/short equity given the dispersion and required expertise to invest in these sectors. The majority is split between long/short equity and event driven strategies with the exception of some fixed income RV. We have a good mix between low net and long-biased strategies and are balanced across style, market cap and geography. Hedge funds are about 18% of the portfolio and have allowed us to take more risk elsewhere in the book given their ability to preserve capital in periods of heightened volatility.

I genuinely enjoy speaking to portfolio managers, evaluating the people, understanding the process, digging into philosophies and analyzing performance. It requires a combination of qualitative and quantitative analysis. We’re looking for consistent alpha generation and unique exposure. We rely on Evestment and Pivotal Path to run the analytics. We run regressions on factors, calculate long/short spread, analyze exposure changes and discuss investment cases. We want to properly set expectations so we know how the manager should perform over various environments. We spend a lot of time upfront getting to know managers prior to investing because we intend to have long-term commitments to our partnerships. 

CIO: Is cryptocurrency a flash in the pan, or an asset of lasting value?

Kenney: I believe cryptocurrency is an asset of lasting value. I know BTC recently fell more than 50% from its peak in mid-April and a measure of implied volatility on BTC similar to the VIX hit 130. It’s still a nascent asset class so crypto will continue to experience these bouts of extreme volatility until it is more widely accepted by the institutional investor community. Many see the past two weeks as being similar to the drop in 2017when China suspended onshore cryptocurrency exchanges and blocked ICOs. A series of events last week caused the precipitous drop in cryptos including China’s desire to restrict BTC mining and trading, the Treasury stating that any crypto transactions over $10,000 will need to be reported to the IRS (Jerome Powell also said the Fed is working on a digital dollar, similar to China), and Elon Musk said that TSLA would stop accepting BTC as payment because of environmental concerns in cryptocurrency mining. These issues seem to be temporary.

Elon did later confirm that TSLA would not be selling the $1.5B of BTC purchased by the company. Regarding energy consumption, the Crypto Climate Accord could be a game changer with several objectives, the main one being the desire to achieve net-zero emissions for the industry by 2030. More cryptocurrencies will most likely use a Proof of Stake network in the future and move away from Proof of Work, which is the network for bitcoin. Proof of Stake networks consume less energy. Perhaps the biggest influence in the recent cryptocurrency selloff is leverage. Some BTC traders were allegedly using 100-to-1 leverage to buy BTC.

This will inspire more regulation which should be good for the stability of the asset. It may also lead to the creation of a Bitcoin ETF. We’ll see if SEC Chair Gary Gensler, who taught classes on blockchain and other fintech at MIT proposes the regulation recently calling cryptocurrencies securities. The global cryptocurrency market cap is around $1.5 trillion of which BTC is about 44% and ETH is close to 19%. Companies including TSLA, SQ, and MSTR have purchased BTC. SQ and PYPL allow users to buy/sell BTC. PYPL recently launched their crypto checkout service. JPM recently announced that they would offer an actively managed bitcoin fund to wealthy clients.

COIN went public and I’ve seen investment managers (not only dedicated crypto hedge funds) open accounts to add cryptocurrencies to their portfolios. This week, GS declared Bitcoin a new asset class. Ray Dalio said he would rather hold BTC than bonds. Last fall, Paul Tudor Jones reiterated his support for bitcoin by calling it the best inflation hedge. Coinmarketcap.com has 5,320 cryptocurrencies listed on their site. Different cryptos have different functions or use cases, which is why so many exist. I’m not sure which will ultimately survive. But some will most likely emerge to challenge BTC and ETH. BTC is the leader because it was the first and it has scarcity value. Only 21 million bitcoins were created of which 18.6 million have been mined. As for the technology behind cryptocurrency, blockchain, there is much more to come.

CIO: What place does blockchain in tomorrow’s financial scene?

Kenney: There will be many applications built on blockchain technology in the future and these will be used across industries. There are many industries that are already using blockchain as it has been more widely adopted than cryptocurrencies.

While at the New York Times DealBook Conference in November, Jamie Dimon said “The blockchain itself will be critical to letting people move money around the world cheaper. We will always support blockchain technology.” (Reported by Coindesk.) Ethereum is the most well-known blockchain that can currently accommodate these applications. Blockchain being a distributed database has many advantages over a centralized ledger including speed, accuracy, transparency and cost.

The most influential function in the future will be Decentralized Finance (DeFi). DeFi means that financial services are offered to the public without an intermediary like a bank or brokerage. Instead, the bank is replaced by a smart contract. Smart contracts are those upon which are automatically executed when certain conditions are met. Examples of current applications are Decentralized Exchanges and Decentralized Lending. We are in the early days of DeFi and there are security issues that will need to be resolved, but it will ultimately be a monumental change to the financial industry.

CIO: How will ESG change investing going forward?

Kenney: Asset managers and allocators alike will focus more on ESG factors as part of their investment processes. Managers will incorporate non-financial factors into their analysis and go beyond traditional research and financial modeling. Resources dedicated to ESG will vary depending on the size of the organization, but we typically see one to two people/team focused on this area or it may be the responsibility of each analyst as part of their due diligence on a company. The intent will be for risk mitigation, but also motivated by institutional investor demand. As several of our managers will say, governance has always been a strong consideration, especially in EM. Environmental and social aspects have grown considerably over the past five to 10 years.

Asset managers will continue to join the UNPRI; many of our managers are signatories. I think the requirements to join or to continue UNPRI membership will become more arduous. Consultants have also made ESG a priority on behalf of their clients who require more transparency and disclosure. Allocators can easily benchmark their managers to indices, e.g. MSCI SRI Indexes. Companies and investors also subscribe to Sustainalytics for their ESG Risk Ratings. There are different approaches to ESG investing. There are positive/negative screens used to include/remove companies or sectors, which is more associated with SRI. Several of our managers employ ESG integration where ESG factors are considered part of the investment decision. ESG engagement or activism is going a step further. These managers work with companies to make changes that will have a financial impact on the organization.

We have an activist investor in our portfolio focused on climate change. Impact investing, which we have within our private capital book is expected to produce a positive social and/or environmental outcome combined with a financial return. Given the popularity of ESG, it will be important for investors to be more discerning among managers who claim to have an ESG strategy in an effort to avoid greenwashing. Similarly, capital flows into highly rated ESG companies or ESG strategies can result in valuation premiums, e.g. renewable energy in 2020. In the short-term, investors focused just on ESG strategies could experience higher tracking error from broad benchmarks along with less diversification across asset classes. However, this will change over time. ESG investing has grown tremendously over the past five to 10 years and will only accelerate under President Biden and in the post-pandemic era.

CIO: What asset class or investment troubles you most right now—and why?

Kenney: Equity valuations are stretched, particularly for certain sectors of the market like Consumer Discretionary and IT – even with the NASDAQ trailing the S&P by 5.3% YTD. There are still many shifts and rotations (sector / style / thematic – WFH vs. recovery/reflation/cyclical trade) occurring under the surface; however, the S&P 500 is sitting near an all-time high and is up 34% over the past year. Regardless of the metric applied, e.g. P/E, CAPE, P/B, P/CF – all are ahead of their 25-year averages. Market cap-to-GDP (“Buffett Indicator”) indicates that the market is significantly overvalued. But maybe these levels can be justified by low rates. Low rates have pushed investors out on the risk curve and the massive amount of stimulus over the past year (with likely more to come) has been an additional tailwind. Future returns have been pulled forward.

There’s a lot of liquidity in the system and even with some short-lived periods of volatility, the market still seems complacent. For so long, investors have been conditioned to buy the dip with the Fed put in play. Ultimately, valuations should revert to their long-term averages. It means that expectations, at least over the intermediate term (five to seven years) should be lower and this should be reflected in capital market assumptions. A continuation of higher rates, higher inflation, proposed higher taxes being passed and/or Fed tapering could all derail this market and cause a correction.

CIO: What investing decision have you made that you’re most proud of?

Kenney: When I joined Furman, we had one-line item for EM equity at around 7% to 8% of the portfolio. Due to some organizational changes for the manager combined with a sustained period of underperformance, we decided to make a change and divide the exposure by style and market cap. We created a universe and ran the analytics in Evestment (formerly PerTrac) in an effort to construct an all-weather EM equity lineup. One manager I recommended has a systematic approach to EM small cap equity, but relies on fundamental inputs to make decisions. The strategy demonstrated early success, but was slow to attract inflows relative to peers who had similar strategies using strictly fundamental, bottom-up analysis and had launched around the same time. As you’re doing your research, you always wonder, “what am I missing?” Or, “what could invalidate my thesis?” I think it’s healthy to have a skeptical mindset.

I also try to be aware of my biases. I spent a lot of time to fully understand the process, the inputs, the systems, etc. until I had enough conviction to make the recommendation. We invested in March 2014 when the strategy had around $200 million in AUM. It became one of the firm’s most successful strategies and was closed to new and existing LPs.

Today, the AUM is around $2 billion. It was an early investment that I recommended and we recently hit our seven-year anniversary. Over our investment period, the firm has asked me to be a reference a few times for this strategy, which I don’t mind because I think it demonstrates how much work I put into the project.

CIO: Who is the manager you don’t currently work with whose brain you’d most like to pick for an hour?

Kenney: Stan Druckenmiller. I always enjoy his commentary and try to listen in when he makes an appearance on CNBC. He closed his fund in August 2010, which became the Duquesne Family Office, but his returns over his time as a hedge fund manager are remarkable.